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T.C. Memo. 2004-280
UNITED STATES TAX COURT
DELAWARE CORP., ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 2040-02, 2041-02,
2042-02.
Filed December 16, 2004.
Harry L. Cohn, for petitioners.
Dustin M. Starbuck, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CHIECHI, Judge:
Respondent determined the following defi-
ciencies in, and accuracy-related penalties under section
1
Cases of the following petitioners are consolidated herewith: Frances B. Havens (Ms. Havens), docket No. 2041-02; and
Oscar M. Barber (Mr. Barber), docket No. 2042-02.
- 2 6662(a)2 on, each petitioner’s Federal income tax (tax):
Petitioner
Delaware Corporation
Year
1994
1997
Deficiency
$37,794
12,366
Accuracy-Related
Penalty
$3,581.40
2,473.20
Mr. Barber
1994
1995
6,710
495
1,342.00
99.00
Ms. Havens
1994
1995
12,637
7,285
2,527.40
1,457.00
The issues remaining for decision in these consolidated
cases are:3
(1) Do Delaware Corporation’s payments during 1994 of
certain expenses with respect to a farm in Caroline County,
Virginia (Caroline County farm), constitute for that year constructive dividends to Ms. Havens that Delaware Corporation is
not entitled to deduct?
We hold that they do.
(2) Do Delaware Corporation’s payments during 1994 and 1995
2
All section references are to the Internal Revenue Code
(Code) in effect at all relevant times. All Rule references are
to the Tax Court Rules of Practice and Procedure.
3
In addition to the issues remaining for decision listed
below, there are other questions relating to certain determinations in the notice of deficiency (notice) issued to Ms. Havens
(Ms. Havens’s notice) with respect to her taxable years 1994 and
1995 that are computational in that their resolution flows
automatically from our resolution of certain of the issues that
we address herein. Moreover, Delaware Corporation and respondent
agree that the Court’s resolution of certain of the issues
remaining for decision will resolve whether Delaware Corporation
is entitled to a net operating loss (NOL) deduction for 1997 that
is attributable to a claimed NOL carryforward from 1995.
- 3 of certain expenses with respect to certain real property in
Virginia Beach, Virginia (Virginia Beach property), constitute
for those years constructive dividends to Ms. Havens that Delaware Corporation is not entitled to deduct?
We hold that they
do.
(3) Is Delaware Corporation entitled for 1994 and 1995 to
depreciation deductions with respect to the Virginia Beach
property?
We hold that it is not.
(4) Do Delaware Corporation’s payments during 1994 of
certain legal fees constitute for that year constructive dividends to Mr. Barber that Delaware Corporation is not entitled to
deduct?
We hold that they do.
(5) Do Delaware Corporation’s payments during 1994 and 1995
of certain child care expenses constitute for those years constructive dividends to Mr. Barber that Delaware Corporation is
not entitled to deduct?
We hold that they do.
(6) Is Delaware Corporation liable for each of the years
1994 and 1997 for the accuracy-related penalty under section
6662(a)?
We hold that it is.
(7) Is Mr. Barber liable for each of the years 1994 and 1995
for the accuracy-related penalty under section 6662(a)?
We hold
that he is.
(8) Is Ms. Havens liable for each of the years 1994 and 1995
for the accuracy-related penalty under section 6662(a)?
We hold
- 4 that she is.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time it filed its petition, the principal place of
business of Delaware Corporation was in Virginia.
Mr. Barber and
Ms. Havens resided in Virginia at the time they filed their
respective petitions.
Background
At all relevant times, Delaware Corporation was a commercial
and industrial construction company.
Prior to August 1, 1993,
Mr. Barber owned 100 percent of the stock of Delaware Corporation.
During 1994 and 1995, Delaware Corporation did not have a
written employee benefits plan.
During at least part of 1994 and
1995, Mr. Barber’s two daughters (Mr. Barber’s daughters) worked
for Delaware Corporation, although not at the same time.
Some time prior to June 2, 1992, Mr. Barber was convicted of
marijuana conspiracy for which he was incarcerated.
Before Mr.
Barber’s incarceration, he and his then wife Laura Barber (Ms.
Barber) resided on property located in Middlesex County, Virginia
(Mitchums Creek property), which they owned as joint tenants.
After Mr. Barber’s release from prison on June 2, 1992, he did
not return to live at the Mitchums Creek property, where Ms.
Barber continued to reside.
A few years before Mr. Barber’s release from prison, he
- 5 applied to a bank for a loan and offered to use the Mitchums
Creek property as collateral.
As a condition to approving that
loan application while Mr. Barber was in prison, the bank requested Mr. Barber to sign a deed (Mitchums Creek deed) conveying
to Ms. Barber his interest as a joint tenant in the Mitchums
Creek property, which he did.
Mr. Barber gave the Mitchums Creek
deed to Ms. Barber but did not intend that she record that deed
unless and until he defaulted on his loan payments.
While Mr. Barber was incarcerated, he and Ms. Barber divorced.
Thereafter, but while Mr. Barber was still in prison,
Ms. Barber recorded the Mitchums Creek deed.
It was not until
after his release from prison that Mr. Barber discovered that Ms.
Barber had recorded that deed, whereupon he commenced litigation
(litigation with respect to the Mitchums Creek property) against
her in the Circuit Court of Middlesex County (Middlesex Circuit
Court).
In that litigation, Mr. Barber claimed that he and Ms.
Barber as joint tenants, and not Ms. Barber alone, owned the
Mitchums Creek property.
Some time after August 1, 1993, the
Middlesex Circuit Court found that Ms. Barber had fraudulently
induced Mr. Barber to convey to her his interest in the Mitchums
Creek property.
That court ordered a rescission of the Mitchums
Creek deed and a so-called equitable distribution of the Mitchums
Creek property to both Mr. Barber and Ms. Barber.
In January 1988, Ms. Havens purchased for $300,000 the
- 6 Virginia Beach property on which was situated a colonial-style,
brick, 2,900 square-foot house.
That house had four bedrooms,
three full baths, a detached two-car garage, and an in-ground
swimming pool.
At all relevant times, including during 1993,
1994, and 1995, Ms. Havens resided at the Virginia Beach property.
At some time prior to August 1, 1993, Ms. Havens purchased
the Caroline County farm.
Some time between June 3, 1992, and August 1, 1993, Mr.
Barber met Ms. Havens at a social gathering.
At that gathering,
Mr. Barber learned from Ms. Havens that she owned 60 percent of
the stock of a very successful corporation known as Management
Systems Applications, Inc. (MSA), and that MSA’s subsidiary
Management Systems Applications, Inc. Kuwait, LLC (MSA-Kuwait),
was having certain problems while conducting its business in
Kuwait.
Mr. Barber offered to assist Ms. Havens in resolving
those problems.
Although wary of Mr. Barber because he had
recently been released from prison, Ms. Havens accepted Mr.
Barber’s offer and caused MSA-Kuwait to hire Mr. Barber.
Mr.
Barber’s work with MSA-Kuwait lasted approximately one year,
during which time he traveled to Kuwait several times.
At a time not disclosed by the record after June 2, 1992,
and before August 1, 1993, Ms. Havens and Mr. Barber formed and
owned Marion-Booker (Marion-Booker), a Virginia limited liability
company.
Marion-Booker purchased certain real property (Chick
- 7 Cove property) at Chick Cove Manor in Middlesex County, Virginia,
which it intended to sell after it caused a house to be built
thereon.
During 1993, 1994, and 1995, Mr. Barber stayed at various
times at the Virginia Beach property, at the Chick Cove property,
and at a house located in Topping, Virginia.
Certain Transactions Involving Delaware
Corporation, Ms. Havens, and Mr. Barber
At least during the period June 2, 1992, to August 1, 1993,
Delaware Corporation did not have the assets or capitalization
that Mr. Barber believed was necessary to secure the financing
and the bonding that it required in order to bid successfully on
major construction projects.
During that period, Ms. Havens and
Mr. Barber discussed between themselves and with Robert L. Braun
(Mr. Braun)4 the use by Delaware Corporation of certain of Ms.
Havens’s assets and certain of Mr. Barber’s assets for the
purpose of enhancing Delaware Corporation’s ability to secure
such financing and such bonding (Ms. Havens’s and Mr. Barber’s
plan).
Mr. Braun recommended that Delaware Corporation, Ms. Havens,
and Mr. Barber use a so-called contract of purchase, and not a
deed of trust, in order to effect Ms. Havens’s and Mr. Barber’s
4
Mr. Braun is a certified public accountant who since 1978
provided various professional services to Delaware Corporation
and Mr. Barber.
- 8 plan.
In recommending the use of a contract of purchase, Mr.
Braun advised Delaware Corporation, Ms. Havens, and Mr. Barber
that such a contract (1) would not trigger the due-on-sale clause
in favor of the first mortgage holder of any mortgage loan with
respect to any property that they wished to use to carry out Ms.
Havens’s and Mr. Barber’s plan and (2) would be reflected in
Delaware Corporation’s financial statements as a stockholder loan
that would be treated as equity for purposes of that company’s
ability to obtain bonding.
Mr. Braun also advised Delaware
Corporation, Ms. Havens, and Mr. Barber that no recording costs
would have to be paid if a contract of purchase were used since
under such a contract no deed would be recorded.
In addition,
based on information provided to him, Mr. Braun advised petitioners that the respective properties of Ms. Havens and Mr. Barber
that they intended to use in effecting Ms. Havens’s and Mr.
Barber’s plan were rental properties and that Delaware Corporation would be entitled to deduct the operating expenses relating
to any such rental property provided that the rent was paid for
such property.
Some time shortly before August 1, 1993, Delaware Corporation, Ms. Havens, and Mr. Barber caused contracts of purchase to
be prepared in order to implement Ms. Havens’s and Mr. Barber’s
plan, and Mr. Braun reviewed those contracts.
Delaware Corporation, Ms. Havens, and Mr. Barber entered
- 9 into an agreement (1993 global agreement), effective as of August
1, 1993, which provided in pertinent part:
THIS AGREEMENT, made as of and effective this 1st
day of August, 1993, by and between FRANCES B. HAVENS
(“Havens”), and OSCAR M. BARBER (“Barber”), and DELAWARE CORPORATION (“DC”),
STATEMENTS:
A.
Barber is 100% owner of all of the stock of DC.
B.
Havens is the owner of property known as 1316
Harris Road, Virginia Beach, Virginia, (the “Virginia Beach property) and 185 acres, Reedy Church
District, Caroline County, Virginia (the “Caroline
County property”).
C.
Havens and Barber are the owners of Marion-Booker,
a Virginia limited liability company, which owns a
lot with improvements thereon at Chick Cove Manor,
Middlesex County, Virginia.
D.
Barber has and/or is asserting an ownership interest in property on Mitchum’s Creek in Middlesex
County, Virginia.
E.
Havens is a 60% owner of Management Systems Applications, Inc., a Virginia corporation.
F.
Havens owns a 30% interest in MSA-Kuwait, LLC
[MSA-Kuwait] a Virginia limited liability company
and DC owns a 30% interest in MSA-Kuwait, LLC.
G.
The parties have agreed and desire that the Caroline County property, the Virginia Beach property,
the interest in MSA-Kuwait owned by Havens and the
Mitchum Creek property, and the Marion-Booker
property be transferred to DC, for DC to enter
into a management contract with Management Systems Applications, Inc. (“MSA”) and for Havens to
acquire a stock ownership in DC as set forth below:
WITNESSETH:
NOW, THEREFORE IN CONSIDERATION of $10.00 cash in
- 10 hand paid by DC to Havens and to Barber and the receipt
of which is hereby acknowledged and for other good and
valuable considerations including the mutual promises
contained herein the parties agree as follows:
1.
The Caroline County property will be transferred
to DC for consideration of $715,000.00, which
includes the assumption by DC of the existing
indebtedness in favor of Colonial Farm Credit ACA
[in] the approximate amount of $394,800.00. This
transfer will be by way of a land sales contract.
The difference between the present indebtedness of
$394,800.00 and $715,000.00 will be evidenced by a
promissory note payable to Havens bearing interest
at the lowest rate allowed by law to prevent the
imputation of interest. Such note shall be due
and payable upon the sale of the Caroline County
property. If the parties terminate this agreement
or at DC’s option if the management contract referred to herein is not renewed, DC will convey
its interest in the property back to Havens, the
aforesaid note shall be cancelled and DC will be
relieved from any further obligations for payment
under the indebtedness to Colonial Farm Credit
ACA. Any moneys spent by DC for maintenance or
for interest on the indebtedness will be at DC’s
expense not to be reimbursed to DC if the Caroline
property is reconveyed to Havens.
2.
The Virginia Beach property will be transferred to
DC for consideration of $300,000.00, which includes the assumption by DC of the existing indebtedness in favor of Crestar Mortgage Corp. [in]
the approximate amount of $172,000.00. This
transfer will be by way of a land sales contract.
The difference between the present indebtedness of
$172,000.00 and $300,000.00 will be evidenced by a
promissory note payable to Havens bearing interest
at the lowest interest rate allowed by law to
prevent the imputation of interest. Such note
shall be due and payable upon the sale of the
Virginia Beach property. If the parties terminate
this agreement or at DC’s option if the management
contract referred to herein is not renewed, DC
will convey its interest in the property back to
Havens, the aforesaid note shall be cancelled and
DC will be relieved from any further obligations
for payment under the indebtedness to Nations
- 11 Bank. Any moneys spent by DC for maintenance or
for interest on the indebtedness will be at DC’s
expense not to be reimbursed to DC if the Virginia
Beach property is reconveyed to Havens.
3.
Havens will transfer to DC a 30% interest in MSAK.
If a dispute arises, the operating agreement dated
August 1, 1993 will prevail. If the parties terminate this agreement or at the option of DC if
the management agreement is not renewed, the 30%
interest in MSAK will revert to Havens without
regard to increase in value. Provided, however,
DC will be entitled to keep its 30%.
4.
Barber will convey his interest in the Mitchum’s
Creek property to DC by land sales contract for
$50,000.00 plus the payment of debts to Rumsey,
Breeden, Hubbard, Bugg & Terry and to Braun,
Dehnert, Clarke & Co. DC will pay all expenses in
recovering the house and anything that has to be
paid to Laura Barber. The deed of Barber’s interest will be delivered to DC at the earliest time
he is able to convey such interest.
5.
Havens will cause MSA to enter into a management
agreement with DC on the terms and conditions set
forth in that management agreement dated August 1,
1993 which is made a part hereof by this reference.
6.
Upon execution and delivery of all of the documents enumerated herein to DC, DC will issue to
Havens sufficient stock so that after the issuance
51% of DC will be owned by Barber and 49% will be
owned by Havens. Notwithstanding this stock ownership percentages, all profit and loss distributions and capital distributions will be split 5050. Also notwithstanding anything contained
herein to the contrary, with regard to matters
involving MSA, Havens will have the right to direct same, such not to be overridden by Barber.
7.
Should this agreement be terminated by the mutual
agreement of the parties, or should DC elect to
terminate this agreement because of the management
contract not being renewed, generally except as
otherwise regarded herein, the parties agree to
take all actions necessary to place themself in a
- 12 position that they were in immediately prior to
the effective date of this agreement. For purposes of illustration the Caroline property, the
Virginia Beach property, half of the MSAK interest
would be returned to Havens. The Mitchums Creek
property would be split 50-50. In the event of
such termination or dissolution, the parties agree
that total assets of DC will be assigned a fair
market value, with Havens being entitled to 50% of
the total fair market value and Barber entitled to
50% of the total fair market value; provided,
however, Havens shall be entitled to receive as
part of her 50% share, the equities accumulated in
the aforementioned properties. In the event of
termination or dissolution, Havens agrees to convey all of her right, title and interest in DC
back to DC or to Barber. [Reproduced literally.]
Pursuant to the 1993 global agreement, Delaware Corporation
and MSA entered into a management contract (1993 management
contract).
The 1993 management contract, which was effective as
of August 1, 1993, provided in pertinent part as follows:
THIS MANAGEMENT CONTRACT [is] made and effective
as of August 1, 1993, between The Delaware Corporation
* * * (“DC”) and Management Systems Applications, Inc.
* * * (“MSA”).
STATEMENTS:
*
*
*
*
*
*
*
C.
MSA desires to enter into a Management contract with DC for DC to supply management services to
MSA.
*
*
*
*
*
*
*
- 13 1.
DURATION AND CANCELLATION
The initial term of this contract shall be for one
(1) year; beginning on the effective date of this
contract and ending at 12:00 midnight on July 31, 1994.
After the expiration of the initial term, this agreement will continue in effect on a year to year basis on
the saine [sic] terms and conditions until canceled by
either party. * * *
*
9.
*
*
*
*
*
*
MANAGEMENT FEES
A.
In return for the management services provided by DC to MSA under this contract, MSA shall
negotiate the fees for each contract function assigned
to DC.
B.
As an incentive under this Agreement, in
addition to the fees under Paragraph A above, DC shall
be paid an amount equal to 5% of the pre-tax profits of
MSA resulting from or because of management improvements by DC, for each calender year. * * *
Pursuant to paragraph 9(A) of the 1993 management contract, MSA
paid Delaware Corporation $30,000 per month for a period not
disclosed by the record.
Pursuant to the 1993 global agreement, Ms. Havens entered
into a contract of purchase that purported to sell to Delaware
Corporation the Caroline County farm (Caroline County farm
contract).
The Caroline County farm contract, which was effec-
tive as of August 1, 1993, provided in pertinent part:
THIS CONTRACT OF PURCHASE, entered into as of the
1st day of August, 1993, by and between FRANCES B.
HAVENS (hereinafter referred to as “Seller”) and DELAWARE CORPORATION (hereinafter referred to as “Purchaser”).
- 14 STATEMENTS:
A.
The Seller agrees to sell and the Purchaser
agrees to buy the property described on Exhibit A
attached hereto and made a part hereof by this reference (the “Caroline County property”) upon certain
terms and conditions contained therein; and
B.
The parties hereto have agreed that such sale
and purchase be by contract and that the deed of conveyance be delivered when such contract has been completed in full.
*
*
*
*
*
*
*
The Pur2.
The Property and Restrictions.
chaser agrees to purchase and the Sellers [sic] agree
to sell the property described in Exhibit A.
The
3.
Purchase Price and Terms of Payment.
price of the property shall be $715,000.00 with the
present indebtedness being assumed by the Purchaser and
the balance evidenced by a promissory note payable by
the Purchaser upon the sale of such parcel.
The Purchaser agrees that the unpaid balance shall
bear interest at the lowest rate allowed by law to
prevent the imputation of interest per annum from the
date hereof, such interest to be payable annually. Any
payments are to be applied first to the payment of
interest on any unpaid balances of the purchase price
and second to the reduction of the principal amount of
the purchase price.
Until the sale of the parcel, Delaware Corp. shall
be responsible for payment of all indebtedness which
constitute[s] a lien against the parcel.
Upon the entire
4.
Deed Upon Full Payment.
balance of the purchase price of the parcel being paid
in full, the Purchaser shall be entitled to receive a
deed for that parcel * * *.
*
*
*
*
*
*
*
8.
Risk of Loss.
From the date hereof, risk of
loss or damage to the properties by fire, windstorm,
casualty or other cause is assumed by the Purchaser.
- 15 9.
Insurance.
Purchaser is to procure and
carry at Purchaser’s expense fire and casualty insurance on improvements to the property in an amount not
less than the replacement value with such policies
naming Seller as first loss payee and Purchaser as
second loss payee. Purchaser shall also procure and
carry out at its expense liability insurance in favor
of the Seller affording protection to the limit of
$500,000.00 in respect to injury or death to a single
person and to the limit of $500,000.00 in respect of
any one accident. Purchaser shall provide the Seller
with a copy of such policies and agree to maintain same
during the term of this contract.
*
*
*
*
*
*
*
12. Possession of Property. The Purchaser may
enter into possession of such property as of August 1,
1993, and continue in such possession for and during
the life of this agreement. The Purchaser shall maintain such premises and all improvements thereon in good
repair, shall permit no waste thereof, and shall take
the same care thereof that a prudent owner would take.
During the life of this agreement Purchaser may not
improve such property without the Seller’s consent in
writing. * * *
No transfer or assignment of
13. Assignment.
any rights hereunder shall be made by anyone having an
interest herein, unless made in writing and in such
manner and on such terms and conditions required by the
Seller.
*
*
*
*
*
*
*
Notwithstanding anything contained
16. Loans.
herein to the contrary, the Purchaser may mortgage the
property to pay off the purchase price, with the consent of Seller.
*
*
*
*
*
*
*
20. Construction.
This agreement shall be
interpreted under the laws of the Commonwealth of
Virginia and shall not be construed against either
party as drafter.
Pursuant to the Caroline County farm contract, Delaware
- 16 Corporation assumed the balance of Ms. Havens’s $394,800 mortgage
loan with respect to the Caroline County farm and gave Ms. Havens
a promissory note (Caroline County farm note) for the remaining
$320,200 of the $715,000 purchase price set forth in that contract.
The Caroline County farm note provided in pertinent part:
Delaware Corporation, a Virginia corporation, promises
to pay to the order of Frances B. Havens * * * the sum
of $320,200 due and payable upon the sale of the property at Reedy Church District, Caroline County, Virginia * * *.
This note bears interest at the lowest rate of
interest per annum allowed by law from time to time to
prevent the imputation of interest. * * *
At all relevant times after July 31, 1993, the Caroline County
farm remained unsold, and Delaware Corporation did not make any
payments to Ms. Havens on the Caroline County farm note.
Pursuant to the 1993 global agreement, Ms. Havens entered
into a contract for purchase that purported to sell to Delaware
Corporation the Virginia Beach property (Virginia Beach property
contract).
The Virginia Beach property contract, which was
effective as of August 1, 1993, provided in pertinent part:
THIS CONTRACT OF PURCHASE, entered into as of the
1st day of August, 1993, by and between FRANCES B.
HAVENS (hereinafter referred to as “Seller”) and DELAWARE CORPORATION (hereinafter referred to as “Purchaser”).
STATEMENTS:
A.
The Seller agrees to sell and the Purchaser
agrees to buy the property described on Exhibit A
attached hereto and made a part hereof by this reference (the “Virginia Beach property”) upon certain terms
- 17 and conditions contained therein; and
B.
The parties hereto have agreed that such sale
and purchase be by contract and that the deed of conveyance be delivered when such contract has been completed in full.
*
*
*
*
*
*
*
The Pur2.
The Property and Restrictions.
chaser agrees to purchase and the Sellers [sic] agree
to sell the property described in Exhibit A.
3.
Purchase Price and Terms of Payment.
The
price of the property shall be $300,000.00 with the
present indebtedness being assumed by the Purchaser and
the balance evidenced by a promissory note payable by
the Purchaser upon the sale of such parcel.
The Purchaser agrees that the unpaid balance shall
bear interest at the lowest rate allowed by law to
prevent the imputation of interest per annum from the
date hereof, such interest to be payable annually. Any
payments are to be applied first to the payment of
interest on any unpaid balances of the purchase price
and second to the reduction of the principal amount of
the purchase price.
Until the sale of the parcel, Delaware Corp. shall
be responsible for payment of all indebtedness which
constitute[s] a lien against the parcel.
Upon the entire
4.
Deed Upon Full Payment.
balance of the purchase price of the parcel being paid
in full, the Purchaser shall be entitled to receive a
deed for that parcel * * *.
*
*
*
*
*
*
*
From the date hereof, risk of
8.
Risk of Loss.
loss or damage to the properties by fire, windstorm,
casualty or other cause is assumed by the Purchaser.
9.
Insurance.
Purchaser is to procure and
carry at Purchaser’s expense fire and casualty insurance on improvements to the property in an amount not
less than the replacement value with such policies
naming Seller as first loss payee and Purchaser as
- 18 second loss payee. Purchaser shall also procure and
carry out at its expense liability insurance in favor
of the Seller affording protection to the limit of
$500,000.00 in respect to injury or death to a single
person and to the limit of $500,000.00 in respect of
any one accident. Purchaser shall provide the Seller
with a copy of such policies and agree to maintain same
during the term of this contract.
*
*
*
*
*
*
*
12. Possession of Property. The Purchaser may
enter into possession of such property as of August 1,
1993, and continue in such possession for and during
the life of this agreement. The Purchaser shall maintain such premises and all improvements thereon in good
repair, shall permit no waste thereof, and shall take
the same care thereof that a prudent owner would take.
During the life of this agreement Purchaser may not
improve such property without the Seller’s consent in
writing. * * *
No transfer or assignment of
13. Assignment.
any rights hereunder shall be made by anyone having an
interest herein, unless made in writing and in such
manner and on such terms and conditions required by the
Seller.
*
*
*
*
*
*
*
Notwithstanding anything contained
16. Loans.
herein to the contrary, the Purchaser may mortgage the
property to pay off the purchase price, with the consent of Seller.
*
*
*
*
*
*
*
20. Construction.
This agreement shall be
interpreted under the laws of the Commonwealth of
Virginia and shall not be construed against either
party as drafter.
Pursuant to the Virginia Beach property contract, Delaware
Corporation assumed the balance of Ms. Havens’s $172,000 mortgage
loan with respect to the Virginia Beach property and gave Ms.
- 19 Havens a promissory note (Virginia Beach property note) for the
remaining $128,000 of the $300,000 purchase price set forth in
that contract.
The Virginia Beach property note provided in
pertinent part:
Delaware Corporation, a Virginia corporation, promises
to pay to the order of Frances B. Havens * * * the sum
of $128,000.00 due and payable upon the sale of the
* * * [Virginia Beach property].
This note bears interest at the lowest rate of
interest per annum allowed by law from time to time to
prevent the imputation of interest. * * *
At all relevant times after July 31, 1993, the Virginia Beach
property remained unsold, and Delaware Corporation did not make
any payments to Ms. Havens on the Virginia Beach note.
Pursuant to the 1993 global agreement, Delaware Corporation
and Mr. Barber entered into a contract of purchase (Mitchums
Creek contract) that purported to sell to Delaware Corporation
his interest in the Mitchums Creek property.
The Mitchums Creek
contract, which was effective as of August 1, 1993, while the
litigation with respect to the Mitchums Creek property was
pending in the Middlesex Circuit Court, provided in pertinent
part:
THIS CONTRACT OF PURCHASE, entered into as of the
1st day of August, 1993, by and between OSCAR M. BARBER
(hereinafter referred to as “Seller”) and DELAWARE
CORPORATION (hereinafter referred to as “Purchaser”).
STATEMENTS:
A.
The Seller agrees to sell and the Purchaser
agrees to buy the property described on Exhibit A
- 20 attached hereto and made a part hereof by this reference (the “Middlesex County property”) [Mitchums Creek]
upon certain terms and conditions contained therein;
and
B.
The parties hereto have agreed that such sale
and purchase be by contract and that the deed of conveyance be delivered when such contract has been completed in full.
*
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*
*
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*
The Pur2.
The Property and Restrictions.
chaser agrees to purchase and the Sellers [sic] agree
to sell all of the Seller’s right, title and interest
in and to the property described in Exhibit A.
3.
Purchase Price and Terms of Payment.
The
price of the property shall be $50,000.00 with the
present indebtedness being assumed by the Purchaser
together with all legal and accounting fees with the
balance evidenced by a promissory note payable by the
Purchaser upon the sale of such parcel.
The Purchaser agrees that the unpaid balance shall
bear interest at the lowest rate allowed by law to
prevent the imputation of interest per annum from the
date hereof, such interest to be payable annually. Any
payments are to be applied first to the payment of
interest on any unpaid balances of the purchase price
and second to the reduction of the principal amount of
the purchase price.
Until the sale of the parcel, Delaware Corp. shall
be responsible for payment of all indebtedness which
constitute[s] a lien against the parcel.
Upon the entire
4.
Deed Upon Full Payment.
balance of the purchase price of the parcel being paid
in full, the Purchaser shall be entitled to receive a
deed for that parcel * * *.
*
*
*
*
*
*
*
8.
Risk of Loss.
From the date hereof, risk of
loss or damage to the properties by fire, windstorm,
casualty or other cause is assumed by the Purchaser.
- 21 9.
Insurance.
Purchaser is to procure and
carry at Purchaser’s expense fire and casualty insurance on improvements to the property in an amount not
less than the replacement value with such policies
naming Seller as first loss payee and Purchaser as
second loss payee. Purchaser shall also procure and
carry out at its expense liability insurance in favor
of the Seller affording protection to the limit of
$500,000.00 * * *. Purchaser shall provide the Seller
with a copy of such policies and agree to maintain same
during the term of this contract.
*
*
*
*
*
*
*
12. Possession of Property. The Purchaser may
enter into possession of such property as of August 1,
1993, and continue in such possession for and during
the life of this agreement. The Purchaser shall maintain such premises and all improvements thereon in good
repair, shall permit no waste thereof, and shall take
the same care thereof that a prudent owner would take.
During the life of this agreement Purchaser may not
improve such property without the Seller’s consent in
writing. * * *
No transfer or assignment of
13. Assignment.
any rights hereunder shall be made by anyone having an
interest herein, unless made in writing and in such
manner and on such terms and conditions required by the
Seller.
*
*
*
*
*
*
*
Notwithstanding anything contained
16. Loans.
herein to the contrary, the Purchaser may mortgage the
property to pay off the purchase price, with the consent of Seller.
*
*
*
*
*
*
*
20. Construction.
This agreement shall be
interpreted under the laws of the Commonwealth of
Virginia and shall not be construed against either
party as drafter.
As made clear in paragraph 4 of the 1993 global agreement, the
term “present indebtedness” referred to in paragraph 3 of the
- 22 Mitchums Creek contract included, inter alia, any mortgage
indebtedness outstanding on the Mitchums Creek property and any
legal fees that Mr. Barber owed as of the effective date of the
Mitchums Creek contract for services rendered in connection with
the litigation with respect to the Mitchums Creek property.
Pursuant to the Mitchums Creek contract, Delaware Corporation gave Mr. Barber a promissory note for $50,000.
That promis-
sory note provided in pertinent part:
Delaware Corporation, a Virginia corporation, promises
to pay to the order of Oscar M. Barber * * * the sum of
$50,000.00 due and payable upon the sale of the property at Mitchums Creek Property, Middlesex County,
Virginia * * *.
This note bears interest at the lowest rate of
interest per annum allowed by law from time to time to
prevent the imputation of interest. * * *
Pursuant to the 1993 global agreement, Marion-Booker5 entered into a contract with Delaware Corporation under which
Marion-Booker purported to sell to Delaware Corporation its
interest in the Chick Cove property.
Although, as discussed
above, Mr. Barber stayed at the Chick Cove property at various
times during the period 1993 through 1995, he did not pay rent to
Delaware Corporation during that period for his use of that
property.
At a time not disclosed by the record after the respective
5
As discussed above, Marion-Booker was a Virginia limited
liability company that Ms. Havens and Mr. Barber formed and
owned.
- 23 effective dates of the Caroline County farm contract and the
Virginia Beach property contract, Delaware Corporation completed
several major construction projects for which it had been able to
obtain the financing and the bonding that permitted it to bid
successfully on such projects.
At all relevant times, including the respective effective
dates of the Caroline County farm contract and the Virginia Beach
property contract and all relevant times thereafter during the
taxable years in question,6 petitioners did not intend that Ms.
Havens transfer to Delaware Corporation equitable ownership of
and legal title to the Caroline County farm and the Virginia
Beach property.
Thus, Delaware Corporation assigned its interest
in the Caroline County farm contract (Caroline County farm
assignment) to MSG-STG L.P., a family limited partnership controlled by Ms. Havens.
The Caroline County farm assignment,
which was effective as of November 9, 1994, provided in pertinent
part as follows:
THIS ASSIGNMENT of Contract Interest, made November 9, 1994, by and between DELAWARE CORPORATION, a
Virginia Corporation (Assignor), and MSG-STG L.P., a
Virginia Limited Partnership (Assignee).
6
The taxable years for which respondent determined deficiencies and penalties against Ms. Havens and Mr. Barber are 1994 and
1995. The taxable years for which respondent determined deficiencies and penalties against Delaware Corporation are 1994 and
1997. The deficiency and the penalty that respondent determined
for Delaware Corporation’s taxable year 1997 are attributable to
respondent’s disallowance of a claimed NOL carryforward from its
taxable year 1995.
- 24 *
*
*
*
*
*
*
WHEREAS, the parties to this Assignment wish to
assign to MSG-STG L.P., a Virginia Limited Partnership,
all rights of DELAWARE CORPORATION in and to the August
1, 1993 contract of purchase, to cancel the August 1,
1993 Note in the amount of Three Hundred Twenty Thousand Two Hundred and NO/100 Dollars ($320,200.00), and
to relinquish any and all claims so that DELAWARE
CORPORATION shall not have any equitable claim under
color of title to the property located in Caroline
County, Virginia, purchased by Frances B. HAVENS in
1991, and the legal title to which is still vested in
the name of Frances B. HAVENS under the Court record
documents in Caroline County, Virginia and
WHEREAS, the parties wish the Assignment to allow
Frances B. HAVENS to freely transfer and/or convey or
sell her ownership in the One Hundred Eighty-five (185)
acres, more or less, located in Caroline County, Virginia, free and clear of any claims of interest or
ownership by DELAWARE CORPORATION under the August 1,
1993 contract of purchase.
NOW, THEREFORE, in consideration of the sum of Ten
and NO/100 Dollars ($10.00) paid by MSG-STG L.P., a
Virginia Limited Partnership, to DELAWARE CORPORATION,
receipt of which is hereby acknowledged, and other good
and valuable considerations, the parties hereto agree
as follows:
1. DELAWARE CORPORATION assigns to MSG-STG L.P.,
a Virginia Limited Partnership, all of its legal and
equitable rights in and to the contract of purchase
dated August 1, 1993, by and between Frances B. HAVENS
and DELAWARE CORPORATION for the Caroline County property, reference to which contract is hereby expressly
made and which contract is incorporated into this
agreement.
2. DELAWARE CORPORATION assigns all claims which
it may have, legal or equitable, under any contract or
color of title, to any interest in the One Hundred
Eighty-five (185) acres, more or less, located in
Caroline County, Virginia.
3. The August 1, 1993 Note from DELAWARE CORPORATION payable to Frances B. HAVENS in the amount of
- 25 Three Hundred Twenty Thousand Two Hundred and NO/100
Dollars ($320,200.00) is cancelled effective upon the
date of this agreement.
4. This Assignment and release of contractual
rights and claim under any color of title shall not be
recorded.
Delaware Corporation also assigned its interest in the
Virginia Beach property contract (Virginia Beach assignment) to
Ms. Havens.
The Virginia Beach assignment, which was effective
as of June 1, 1995, provided in pertinent part:
THIS ASSIGNMENT of Contract Interest, made June 1,
1995 by and between DELAWARE CORPORATION, a Virginia
Corporation (Assignor), and Frances B. Havens (Assignee).
*
*
*
*
*
*
*
WHEREAS, the parties to this Assignment wish to
re-assign to Frances Havens all rights of DELAWARE
CORPORATION in and to the August 1, 1993 contract of
purchase, to cancel the August 1, 1993 Note in the
amount of One Hundred Twenty Eight Thousand and No/100
Dollars ($128,000.00), and to relinquish any and all
claims so that DELAWARE CORPORATION shall not have any
equitable claim of title to the property located in
Virginia Beach, Virginia, purchased by Frances B.
Havens in January 1988, and the legal title to which is
still vested in the name of Frances B. HAVENS under the
Court record documents in Virginia Beach, Virginia and
WHEREAS, the parties wish the Assignment to allow
Frances B. HAVENS to freely transfer and/or convey or
sell her ownership in the House and Real Estate, located in Virginia Beach, Virginia free and clear of any
claims of interest or ownership by DELAWARE CORPORATION
under the August 1, 1993 contract of purchase.
NOW, THEREFORE, in consideration of the sum of Ten
and NO/100 Dollars ($10.00) paid by Frances Havens, to
DELAWARE CORPORATION, receipt of which is hereby acknowledged, and other good and valuable considerations,
- 26 the parties hereto agree as follows:
1. DELAWARE CORPORATION assigns to Frances Havens, all of its legal and equitable rights in and to
the contract of purchase dated August 1, 1993, by and
between Frances B. HAVENS and DELAWARE CORPORATION for
the Virginia Beach property, reference to which contract is hereby expressly made and which contract is
incorporated into this agreement.
2. DELAWARE CORPORATION assigns all claims which
it may have, legal or equitable, under any contract or
color of title, to any interest in the House and
Realestate [sic] located in Virginia Beach, Virginia.
3. The August 1, 1993 Note from DELAWARE CORPORATION payable to Frances B. HAVENS in the amount of One
Hundred Twenty Eight Thousand and NO/100 Dollars
($128,000.00) is cancelled effective upon the date of
this agreement.
4. Frances Havens will re-assume the liability of
the pay off balance to Crestar Mortgage Corporation in
the amount of One Hundred Fifty Nine Thousand Nine
Hundred Forty Five and 94/100 Dollars ($159,945.94) and
commence making the monthly payments.
5. Delaware Corporation will deduct from Frances
Havens Loan from Stockholder account Twelve Thousand
Fifty Four and 06/100 Dollars ($12,054.06), which
represents Delaware Corporation’s Equitable interest in
the Virginia Beach Property.
6. This Assignment and release of contractual
rights and claim under any color of title shall not be
recorded.
Some time after the conclusion of the litigation with
respect to the Mitchums Creek property, Ms. Barber purchased for
$75,000 the one-half of that property that the Middlesex Circuit
Court had found she did not own and that Mr. Barber had purported
to sell to Delaware Corporation pursuant to the Mitchums Creek
contract.
- 27 Certain Payments by Delaware Corporation
During the years in question, Delaware Corporation made
certain payments as described below.
Caroline County Farm
During 1994, Delaware Corporation paid the following expenses (1994 Caroline County farm expenses) totaling $49,817 with
respect to the Caroline County farm:
Type of Expense
Mortgage Loan
Real Estate Taxes
Electric Utilities
Telephone
Amount
$44,170
2,418
2,917
312
Virginia Beach Property
During 1994, Delaware Corporation paid the following expenses (1994 Virginia Beach property expenses) totaling $29,202
with respect to the Virginia Beach property:
Type of Expense
Mortgage Loan
Real Estate Taxes
Electric Utilities
Telephone
Television
Propane
Security
Miscellaneous
Amount
$18,627
2,963
4,805
1,682
251
200
482
192
During 1995, Delaware Corporation paid the following expenses (1995 Virginia Beach property expenses) totaling $23,654
with respect to the Virginia Beach property:
- 28 Type of Expense
Mortgage Loan
Real Estate Taxes
Electric Utilities
Telephone
Amount
$18,649
2,963
1,771
271
Mitchums Creek Property
During 1994, pursuant to the Mitchums Creek contract,
Delaware Corporation paid a total of $17,807 in legal fees (legal
fees with respect to the Mitchums Creek property) for legal
services provided to Mr. Barber in connection with the litigation
with respect to the Mitchums Creek property.
Child Care
During 1994 and 1995, Delaware Corporation paid $7,762 (1994
child care expenses) and $3,321 (1995 child care expenses),
respectively, for the care of the children of Mr. Barber’s
daughters.
Delaware Corporation did not treat those payments as
taxable fringe benefits.
Petitioners’ Respective Federal Income Tax Returns
Each petitioner filed tax returns (returns) for the years in
question as described below.
Delaware Corporation’s Returns
Delaware Corporation filed Form 1120, U.S. Corporation
Income Tax Return (Form 1120), for its taxable year 1994 (Delaware Corporation’s 1994 return).
Failes & Associates, P.C., was
the paid preparer (preparer) of that return.
In Delaware Corpo-
ration’s 1994 return, Delaware Corporation claimed the following
- 29 deductions:
(1) $49,817 for the 1994 Caroline County farm
expenses, (2) $29,202 for the 1994 Virginia Beach property
expenses, (3) $17,807 for the legal fees with respect to the
Mitchums Creek property, (4) $7,762 for the 1994 child care
expenses, and (5) $10,909 for depreciation with respect to the
Virginia Beach property (1994 Virginia Beach property depreciation deduction).
In Delaware Corporation’s 1994 return, Delaware
Corporation reported $7,200 as gross rent received with respect
to the Virginia Beach property (1994 claimed rent of $7,200).
Delaware Corporation filed Form 1120 for its taxable year
1995 (Delaware Corporation’s 1995 return).7
In Delaware Corpora-
tion’s 1995 return, Delaware Corporation claimed the following
deductions:
(1) $23,654 for the 1995 Virginia Beach property
expenses, (2) $3,321 for the 1995 child care expenses, and
(3) $5,454 for depreciation with respect to the Virginia Beach
property (1995 Virginia Beach property depreciation deduction).
In Delaware Corporation’s 1995 return, Delaware Corporation
claimed an NOL.8
Delaware Corporation carried part of that NOL
back to its taxable years 1993 and 1994 and, as discussed below,
7
Delaware Corporation’s 1995 return is not part of the
record in this case. We are unable to determine from that record
whether a preparer prepared Delaware Corporation’s 1995 return
and, if so, the identity of such preparer.
8
The record does not disclose the amount of the NOL that
Delaware Corporation claimed in Delaware Corporation’s 1995
return.
- 30 carried the balance (i.e., $74,021) forward to its taxable year
1997.
Delaware Corporation filed Form 1120 for its taxable year
1997 (Delaware Corporation’s 1997 return).
P.C., was the preparer of that return.
Failes & Associates,
In Delaware Corporation’s
1997 return, Delaware Corporation claimed an NOL deduction of
$74,021 that was attributable to a claimed NOL carryforward from
1995.
Ms. Havens’s Returns
Ms. Havens filed Form 1040, U.S. Individual Income Tax
Return (Form 1040), for her taxable year 1994 (Ms. Havens’s 1994
return).
Braun, Dehnert, Clarke & Co., PC, was the preparer of
that return.
In Ms. Havens’s 1994 return, Ms. Havens did not
report as income the following payments that Delaware Corporation
made during 1994:
(1) $49,817 for the 1994 Caroline County farm
expenses and (2) $29,202 for the 1994 Virginia Beach property
expenses.
In Ms. Havens’s 1994 return, Ms. Havens did not report
as income Delaware Corporation’s assignment in 1994 of its
interest in the Caroline County farm contract to MSG-STG L.P., a
family limited partnership controlled by Ms. Havens.
Ms. Havens filed Form 1040 for her taxable year 1995 (Ms.
Havens’s 1995 return).
return.
“KROBOTHs” was the preparer of that
In Ms. Havens’s 1995 return, Ms. Havens did not report
as income $23,654 for the 1995 Virginia Beach property expenses
- 31 that Delaware Corporation paid during 1995.
In Ms. Havens’s 1995
return, Ms. Havens did not report as income Delaware Corporation’s assignment of its interest in the Virginia Beach property
contract to her.
Mr. Barber’s Returns
Mr. Barber filed Form 1040 for his taxable year 1994 (Mr.
A preparer prepared that return.9
Barber’s 1994 return).
In Mr.
Barber’s 1994 return, Mr. Barber did not report as income the
following payments that Delaware Corporation made during 1994:
(1) $17,807 for legal fees with respect to the Mitchums Creek
property and (2) $7,762 for the 1994 child care expenses.
Mr. Barber filed Form 1040 for his taxable year 1995 (Mr.
Barber’s 1995 return).
preparer of that return.
Failes & Associates, P.C., was the
In Mr. Barber’s 1995 return, Mr. Barber
did not report as income $3,321 for the 1995 child care expenses
that Delaware Corporation paid during 1995.
Respondent’s Examination of Petitioners’ Respective Returns
Respondent’s examination of petitioners’ respective returns
for the taxable years in question began prior to July 23, 1998.
Delaware Corporation’s Notice of Deficiency
Respondent issued a notice to Delaware Corporation (Delaware
Corporation’s notice) with respect to its taxable years 1994 and
9
The record does not disclose the identity of the preparer
of Mr. Barber’s 1994 return.
- 32 1997.
In that notice, respondent determined, inter alia, to
disallow the following deductions claimed in Delaware Corporation’s 1994 return:
(1) Real estate taxes of $2,418 attributable
to the Caroline County farm, (2) real estate taxes of $2,963
attributable to the Virginia Beach property, (3) mortgage loan
interest of $29,820 attributable to the Caroline County farm,
(4) mortgage loan interest of $6,350 attributable to the Virginia
Beach property,10 (5) utility expenses of $8,847,11 (6) legal fees
of $17,807 attributable to the litigation with respect to the
10
The parties stipulated that Delaware Corporation made for
1994, and deducted in its 1994 return, $44,170 of mortgage loan
payments with respect to the Caroline County farm and $18,627 of
mortgage loan payments with respect to the Virginia Beach property. Delaware Corporation’s notice showed that for the taxable
year 1994 respondent disallowed $29,820 of mortgage loan interest
deductions with respect to the Caroline County farm and $6,350 of
mortgage loan interest deductions with respect to the Virginia
Beach property. The record does not disclose the reason for the
discrepancies between the respective total amounts of mortgage
loan payments that the parties stipulated Delaware Corporation
made during 1994, and deducted in Delaware Corporation’s 1994
return, with respect to the Caroline County farm and the Virginia
Beach property (i.e., $44,170 and $18,627, respectively) and the
respective total amounts of mortgage loan interest deductions
that respondent disallowed for that year with respect to those
properties (i.e., $29,820 and $6,350, respectively).
11
In Delaware Corporation’s notice, respondent did not show
the disallowed portion of the total expense deductions of $8,847
for utilities that Delaware Corporation claimed in its 1994
return (1) that was attributable to the Caroline County farm and
(2) that was attributable to the Virginia Beach property. The
record establishes that Delaware Corporation paid during 1994
utility expenses of $2,917 attributable to the Caroline County
farm and $5,930 attributable to the Virginia Beach property.
- 33 Mitchums Creek property, (7) telephone expenses of $2,700,12
(8) child care expenses of $7,762, and (9) depreciation of
$10,909 attributable to the Virginia Beach property.
In Delaware
Corporation’s notice, respondent also determined that the 1994
claimed rent of $7,200 should not be included in Delaware Corporation’s gross income for 1994.
In Delaware Corporation’s notice, respondent determined,
inter alia, to disallow the following deductions claimed in
Delaware Corporation’s 1995 return:
(1) Real estate taxes of
$2,963 attributable to the Virginia Beach property, (2) mortgage
loan interest of $11,676 attributable to the Virginia Beach
property,13 (3) utility expenses of $1,777 attributable to the
12
In Delaware Corporation’s notice, respondent did not show
the disallowed portion of the total telephone expense deductions
of $2,700 that Delaware Corporation claimed in its 1994 return
(1) that was attributable to the Caroline County farm and
(2) that was attributable to the Virginia Beach property. The
record establishes that Delaware Corporation paid during 1994
telephone expenses of $312 attributable to the Caroline County
farm and $1,682 attributable to the Virginia Beach property.
Although the record is not clear regarding the property or
properties to which the remaining expenses of $706 are attributable, the parties do not dispute that for 1994 the total telephone expense deductions in dispute are $2,700.
13
The parties stipulated that Delaware Corporation made for
1995, and deducted in its 1995 return, $18,649 of mortgage loan
payments with respect to the Virginia Beach property. Delaware
Corporation’s notice showed that for the taxable year 1995
respondent disallowed $11,676 of mortgage loan interest deductions with respect to that property. The record does not disclose the reason for the discrepancies between the total amount
of mortgage loan payments that the parties stipulated Delaware
Corporation made during 1995, and deducted in Delaware Corpora(continued...)
- 34 Virginia Beach property, (4) telephone expenses of $271 attributable to the Virginia Beach property, (5) child care expenses of
$3,321, and (6) depreciation of $5,454 attributable to the
Virginia Beach property.
As a result of the disallowance of the foregoing deductions,
respondent determined:
(1) To decrease (a) the amount of the NOL
that Delaware Corporation claimed in Delaware Corporation’s 1995
return and (b) the amount of the NOL carryback from 1995 that
Delaware Corporation claimed in its 1993 return and 1994 return
and (2) to eliminate the NOL carryforward from 1995 that Delaware
Corporation claimed in its 1997 return.
In Delaware Corpora-
tion’s notice, respondent further determined that Delaware
Corporation is liable for each of the years 1994 and 1997 for the
accuracy-related penalty under section 6662(a).
Ms. Havens’s Notice of Deficiency
Respondent issued a notice to Ms. Havens with respect to her
taxable years 1994 and 1995.
In that notice, respondent deter-
mined that during 1994 Ms. Havens received constructive dividends
of $79,019 from Delaware Corporation, of which (1) $49,817 was
attributable to the 1994 Caroline County farm expenses that
Delaware Corporation paid during 1994 and (2) $29,202 was attrib-
13
(...continued)
tion’s 1995 return, with respect to the Virginia Beach property
(i.e., $18,649) and the total amount of mortgage loan interest
deductions that respondent disallowed for that year with respect
to the Virginia Beach property (i.e., $11,676).
- 35 utable to the 1994 Virginia Beach property expenses that Delaware
Corporation paid during that year.
In Ms. Havens’s notice,
respondent also determined that during 1995 Ms. Havens received
constructive dividends of $23,654 from Delaware Corporation
attributable to the 1995 Virginia Beach property expenses that
Delaware Corporation paid during that year.
Respondent further
determined in Ms. Havens’s notice that she is liable for each of
the years 1994 and 1995 for the accuracy-related penalty under
section 6662(a).
Mr. Barber’s Notice of Deficiency
Respondent issued a notice to Mr. Barber (Mr. Barber’s
notice) with respect to his taxable years 1994 and 1995.
In that
notice, respondent determined that during 1994 Mr. Barber received constructive dividends of $25,569 from Delaware Corporation, of which (1) $17,807 was attributable to the legal fees
with respect to the Mitchums Creek property that Delaware Corporation paid during 1994 and (2) $7,762 was attributable to the
1994 child care expenses that Delaware Corporation paid during
that year.
In Mr. Barber’s notice, respondent also determined
that during 1995 Mr. Barber received constructive dividends of
$3,321 from Delaware Corporation attributable to the 1995 child
care expenses that Delaware Corporation paid during that year.
Respondent further determined in Mr. Barber’s notice that he is
liable for each of the years 1994 and 1995 for the accuracy-
- 36 related penalty under section 6662(a).
OPINION
Each petitioner bears the burden of proving that respondent’s determinations in the notice that respondent issued to
such petitioner is erroneous.
See Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933).
We must determine whether:
(1) Delaware Corporation’s
payments during 1994 of the 1994 Caroline County farm expenses
and the 1994 Virginia Beach property expenses and during 1995 of
the 1995 Virginia Beach property expenses (collectively, the
disputed property expenses) constitute constructive dividends to
Ms. Havens for those respective years that Delaware Corporation
is not entitled to deduct; (2) Delaware Corporation is entitled
for 1994 to the 1994 Virginia Beach property depreciation deduction and for 1995 to the 1995 Virginia Beach property depreciation deduction (collectively, the Virginia Beach property depreciation deductions); (3) Delaware Corporation’s payments during
1994 of the legal fees with respect to the Mitchums Creek property constitute constructive dividends to Mr. Barber for that
year that Delaware Corporation is not entitled to deduct;
(4) Delaware Corporation’s payments during 1994 of the 1994 child
care expenses and during 1995 of the 1995 child care expenses
(collectively, the disputed child care expenses) constitute
constructive dividends to Mr. Barber for those respective years
- 37 that Delaware Corporation is not entitled to deduct; and
(5) petitioners are liable for the respective years at issue for
the accuracy-related penalties.
It is petitioners’ position that respondent erred in determining:
(1) That Delaware Corporation’s payments of (a) the
disputed property expenses, (b) the legal fees with respect to
the Mitchums Creek property, and (c) the disputed child care
expenses constitute constructive dividends to Ms. Havens or Mr.
Barber, as the case may be, that Delaware Corporation is not
entitled to deduct;14 (2) that Delaware Corporation is not entitled to the Virginia Beach property depreciation deductions; and
(3) that petitioners are liable for the accuracy-related penalties at issue.
In support of their position, petitioners rely
on, inter alia, Mr. Barber’s testimony.
We found his testimony
to be questionable, vague, general, conclusory, and/or uncorroborated in certain material respects.
14
We shall not rely on any
Petitioners do not argue that Ms. Havens and Mr. Barber
did not receive constructive dividends during the years at issue
because of insufficient earnings and profits of Delaware Corporation. See secs. 301(c)(1), 316(a). Nor do petitioners contend
that Delaware Corporation intended (1) the payments of the
disputed property expenses to be compensation to Ms. Havens, and
(2) the payments of the legal fees with respect to the Mitchums
Creek property and the disputed child care expenses to be compensation to Mr. Barber that is deductible by it for the respective
years in question. See Paula Constr. Co. v. Commissioner, 58
T.C. 1055, 1058-1059 (1972), affd. without published opinion 474
F.2d 1345 (5th Cir. 1973).
- 38 such testimony to support petitioners’ position in the instant
cases.
Petitioners did not call Ms. Havens to testify in support of
their position in these cases.
We presume that Ms. Havens did
not testify because her testimony would not have been favorable
to petitioners’ position.
See Wichita Terminal Elevator Co. v.
Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th
Cir. 1947).
1994 Caroline County Farm Expenses, 1994 Virginia Beach
Property Expenses, and 1995 Virginia Beach Property Expenses
In support of their position with respect to the disputed
property expenses, petitioners argue:
Because the Caroline County Farm was investment property held for rent and for resale, DC [Delaware Corporation] may deduct real estate taxes, mortgage interest
and utilities and operating expenses paid by it. * * *
* * * DC can deduct mortgage interest paid on the
Virginia Beach property in 1994 and 1995 and mortgage
interest paid on the Caroline County farm in 1995,
because the Virginia Beach property was rental property. Both pieces were investment property held for
rent and resale. * * *
*
*
*
*
*
*
*
Assets sold to DC were Caroline County farm,
$715,000; Virginia Beach property $300,000; MarionBooker spec house [Chick Cove property], $99,000;
Mitchum’s [sic] Creek property $75,000 and 60% interest
in MSA-Kuwait, total in excess of $1,000,000. This
infusion of capital enabled DC to get back into the
construction business and make a profit.
* * * All these transactions had substantial
economic, commercial and legal effects other then
expected tax benefits. They were in no way an economic
- 39 sham without effect for Federal income tax purposes.
* * *
Respondent counters:
A fundamental principle of income tax law is that
economic substance prevails over form, and in this case
the real estate transactions between petitioners were
without economic substance because petitioner Havens
remained the true owner of the equity in the properties. * * *
*
*
*
*
*
*
*
It is abundantly clear that the real estate transactions between Havens and Delaware Corporation are
without economic substance. Havens always remained in
possession of the properties and controlled the properties as she had done before the transfers. Once the
Court looks through the alleged transfer to Delaware
Corporation, no economic relationships were altered,
and Havens remained the owner of the Virginia Beach and
Caroline County properties.
On the record before us, we reject petitioners’ argument
that as of August 1, 1993, or any time thereafter during the
years in question, Ms. Havens transferred the Caroline County
farm and the Virginia Beach property to Delaware Corporation and
that Delaware Corporation became the owner of those properties.
On that record, we agree with respondent that during the years in
question Ms. Havens remained the owner of both of those properties.
In determining whether the benefits and burdens of ownership
of the Caroline County farm and of the Virginia Beach property
passed from Ms. Havens to Delaware Corporation, we look to Keith
v. Commissioner, 115 T.C. 605 (2000), for guidance.
In Keith v.
- 40 Commissioner, supra at 611-612, we stated:
Case law * * * sets forth the standard for determining when a sale is complete for tax purposes. With
respect to real property, a sale and transfer of ownership is complete upon the earlier of the passage of
legal title or the practical assumption of the benefits
and burdens of ownership. See Major Realty Corp. &
Subs. v. Commissioner, 749 F.2d 1483, 1486 (11th Cir.
1985), affg. in part and revg. in part T.C. Memo. 1981361; Dettmers v. Commissioner, 430 F.2d 1019, 1023 (6th
Cir. 1970), affg. Estate of Johnston v. Commissioner,
51 T.C. 290 (1968); Baird v. Commissioner, 68 T.C. 115,
124 (1977). This test reaffirms the longstanding
principle, evidenced by the following early statement,
that transfer of legal title is not a prerequisite for
a completed sale: “A closed transaction for tax purposes results from a contract of sale which is absolute
and unconditional on the part of the seller to deliver
to the buyer a deed upon payment of the consideration
and by which the purchaser secures immediate possession
and exercises all the rights of ownership.” Commissioner v. Union Pac. R.R. Co., 86 F.2d 637, 639 (2d
Cir. 1936), affg. 32 B.T.A. 383 (1935).
In determining whether passage either of title or
of benefits and burdens has occurred, we look to State
law. It is State law that creates, and governs the
nature of, interests in property, with Federal law then
controlling the manner in which such interests are
taxed. See United States v. National Bank of Commerce,
472 U.S. 713, 722 (1985). Here, execution of the
contracts for deed was not accompanied by a transfer of
legal title, so we must decide whether these instruments were sufficient under State law to confer upon
the purchaser the benefits and burdens of ownership.
This inquiry is a practical one to be resolved by
examining all of the surrounding facts and circumstances. * * *
Among the factors which this and other courts have
cited as indicative of the benefits and burdens of
ownership are: A right to possession; an obligation to
pay taxes, assessments, and charges against the property; a responsibility for insuring the property; a
duty to maintain the property; a right to improve the
property without the seller’s consent; a bearing of the
risk of loss; and a right to obtain legal title at any
- 41 time by paying the balance of the full purchase price.
See Goldberg v. Commissioner, T.C. Memo. 1997-74; see
also Major Realty Corp. v. Commissioner, supra at 1487;
Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C.
1221, 1237-1238 (1981); Musgrave v. Commissioner, T.C.
Memo. 2000-285; Berger v. Commissioner, T.C. Memo.
1996-76; Spyglass Partners v. Commissioner, T.C. Memo.
1995-452. When a buyer, by virtue of such incidents,
would be considered to have obtained equitable ownership under State law, a sale will generally be deemed
completed for Federal tax purposes. * * *
As required by Keith v. Commissioner, supra, we shall
examine the law of the Commonwealth of Virginia (Virginia law)15
to determine whether as of August 1, 1993, or any time thereafter
during the years in question, the Caroline County farm contract
and the Virginia Beach contract conferred on Delaware Corporation
the benefits and burdens of ownership (i.e., equitable ownership)
of the Caroline County farm and the Virginia Beach property.
Under Virginia law, generally when a contract for the sale
and purchase of real property is executed, the equitable ownership (i.e., the benefits and burdens of ownership) of the real
property is transferred from the seller to the buyer.
See Lipps
v. First Am. Serv. Corp., 286 S.E.2d 215, 220 (Va. 1982); Sale v.
Swann, 120 S.E. 870, 873 (Va. 1924).
Where a contract for the
sale and purchase of real property contains a condition precedent, that condition must be satisfied before a party to such
contract may seek specific performance of such contract, see
15
The Caroline County contract and the Virginia Beach contract provided that Virginia law was to govern the interpretation
of those respective contracts.
- 42 Flippo v. F & L Land Co., 400 S.E.2d 156, 160 (Va. 1991), and
before the equitable ownership (i.e., the benefits and burdens of
ownership) of such real property will pass from the seller to the
buyer, see Bauserman v. Digiulian, 297 S.E.2d 671 (Va. 1982).
Virginia law thus is consistent with tax law which requires that
a contract of sale of real property be “absolute and unconditional” in order for such contract to be considered a closed
transaction for tax purposes.
Commissioner v. Union Pac. R.R.,
86 F.2d 637, 639 (2d Cir. 1936), affg. 32 B.T.A. 383 (1935).
In the instant cases, both the Caroline County farm contract
and the Virginia Beach property contract contained conditions
precedent that had to be satisfied.
Delaware Corporation had no
obligation to make any payments of principal to Ms. Havens with
respect to the Caroline County farm note, which under the Caroline County farm contract was part of the purchase price, unless
and until the Caroline County farm was sold.16
Similarly, Dela-
ware Corporation had no obligation to make any payments of
principal to Ms. Havens with respect to the Virginia Beach
property note, which under the Virginia Beach property contract
was part of the purchase price, unless and until the Virginia
16
Ms. Havens had no obligation under the Caroline County
farm contract to deliver a deed for the Caroline County farm
unless and until Delaware Corporation paid the Caroline County
farm note in full.
- 43 Beach property was sold.17
At all relevant times after July 31,
1993, the Caroline County farm and the Virginia Beach property
remained unsold, and Delaware Corporation did not make any
payments to Ms. Havens on the Caroline County farm note or the
Virginia Beach property note.18
In addition, the Caroline County farm contract and the
Virginia Beach contract contained other provisions which indicate
that Ms. Havens did not transfer to Delaware Corporation as of
August 1, 1993, or any time thereafter during the years in
question, the respective benefits and burdens of ownership of the
Caroline County farm and of the Virginia Beach property.
Pursu-
ant to those respective contracts, Delaware Corporation was not
permitted to (1) make any improvements to the respective properties without first obtaining Ms. Havens’s written approval or
(2) mortgage such respective properties to pay the Caroline
County farm note and the Virginia Beach property note, respectively, without the consent of Ms. Havens.
Another factor indicating that Ms. Havens did not transfer
17
Ms. Havens had no obligation under the Virginia Beach
property contract to deliver a deed for the Virginia Beach
property unless and until Delaware Corporation paid the Virginia
Beach property note in full.
18
The Caroline County farm contract and the Virginia Beach
property contract did not specify any dates by which the Caroline
County farm and the Virginia Beach property, respectively, were
to be sold. As a result, the respective maturity dates for the
Caroline County farm note and the Virginia Beach property note
were open-ended.
- 44 to Delaware Corporation as of August 1, 1993, or any time thereafter during the years in question, the benefits and burdens of
ownership of the Virginia Beach property is that Ms. Havens
continued to reside at that property during those years without
paying any rent.19
It is also significant that at all relevant times, including
the respective effective dates of the Caroline County farm
contract and the Virginia Beach property contract and all relevant times thereafter during the taxable years in question,
petitioners did not intend that Ms. Havens transfer to Delaware
Corporation equitable ownership of and legal title to the
Caroline County farm and the Virginia Beach property.
19
Indeed,
Petitioners contend that during 1994 Ms. Havens and Mr.
Barber each paid $3,600 to Delaware Corporation for the rental of
the Virginia Beach property, or a total of $7,200, which they
concede did not equal the annual fair rental value of that
property. In support of that contention, petitioners rely on Mr.
Barber’s testimony. We found such testimony to be questionable,
vague, and uncorroborated, and we shall not rely on it to establish that Mr. Barber paid any amount to Delaware Corporation in
1994 as rent for his use of the Virginia Beach property. Moreover, Mr. Barber’s testimony on which petitioners rely does not
address whether Ms. Havens paid any rent to Delaware Corporation
in 1994 for her use of that property. Petitioners have not
presented any evidence, and make no argument, that during the
years in question Delaware Corporation received any rent for the
Caroline County farm. On the record before us, we find that
petitioners have failed to establish that Ms. Havens and Mr.
Barber (1) paid during 1994 a total of $7,200 as rent for the
Virginia Beach property and (2) paid during the years in question
any rent for the Caroline County farm and the Virginia Beach
property. On that record, we further find that petitioners have
failed to carry their burden of establishing that during the
years in question the Caroline County farm and the Virginia Beach
property were rental properties that Delaware Corporation owned.
- 45 Mr. Braun advised them to treat the Caroline County farm contract
and the Virginia Beach property contract as stockholder loans in
Delaware Corporation’s financial statements.
In addition, both the Caroline County farm assignment and
the Virginia Beach property assignment, which assigned Delaware
Corporation’s respective interests in the Caroline County farm
contract and the Virginia Beach property contract to a family
limited partnership (i.e., MSG-STG L.P.) controlled by Ms. Havens
and to Ms. Havens, respectively, contained acknowledgments that
Ms. Havens continued to own the Caroline County farm and the
Virginia Beach property as of the effective dates of those
assignments.
Those assignments stated in pertinent part:
WHEREAS, the parties wish the Assignment to allow
Frances B. Havens to freely transfer and/or convey or
sell her ownership in the * * * [Caroline County Farm
or the Virginia Beach property] free and clear of any
claims of interest or ownership by DELAWARE CORPORATION
under the August 1, 1993 contract of purchase. [Emphasis added.]
On the record before us, we find that petitioners have
failed to carry their burden of establishing that the Caroline
County farm contract and the Virginia Beach property contract
conferred on Delaware Corporation as of August 1, 1993, or any
time thereafter during the years in question, the respective
benefits and burdens of ownership (i.e., equitable ownership) of
the Caroline County farm and the Virginia Beach property.
With respect to Delaware Corporation’s payments of the
- 46 respective disputed property expenses relating to the Caroline
County farm and the Virginia Beach property that we have found
Delaware Corporation did not own during the years in question, it
is well established that when a corporation confers an economic
benefit on a stockholder in his or her capacity as such, without
an expectation of reimbursement, that benefit constitutes a
constructive dividend to the stockholder.
E.g., Hagaman v.
Commissioner, 958 F.2d 684, 690 (6th Cir. 1992), affg. in part
and remanding in part on another ground T.C. Memo. 1987-549;
Magnon v. Commissioner, 73 T.C. 980, 993-994 (1980).
The exis-
tence of a constructive dividend is a question of fact.
Hagaman
v. Commissioner, supra; Loftin & Woodard, Inc. v. United States,
577 F.2d 1206, 1215 (5th Cir. 1978).
Generally, a corporation
may not claim a deduction in computing its taxable income for a
payment that constitutes a constructive dividend to its stockholder.
See Hillsboro Natl. Bank v. Commissioner, 460 U.S. 370,
392-393 (1983); Va. Natl. Bank v. United States, 450 F.2d 1155,
1157-1158 (4th Cir. 1971); Berkley Mach. Works & Foundry, Inc. v.
Commissioner, 422 F.2d 362 (4th Cir. 1970), affg. per curiam T.C.
Memo. 1968-278.
On the record before us, we find that petitioners have
failed to carry their burden of establishing that during 1994 and
1995 Ms. Havens intended to reimburse Delaware Corporation for
its payments of the respective disputed property expenses with
- 47 respect to the Caroline County farm and the Virginia Beach
property that we have found she owned during the years in question.
On that record, we further find that petitioners have
failed to carry their burden of establishing that during 1994 and
1995 Delaware Corporation’s payments of such expenses did not
confer an economic benefit on Ms. Havens.
Based upon our examination of the entire record before us,
we find that petitioners have failed to carry their burden of
establishing (1) that Delaware Corporation’s payments during 1994
and 1995, respectively, of the disputed property expenses do not
constitute constructive dividends to Ms. Havens for those years
and (2) that Delaware Corporation is entitled to deduct such
expenses for those years.
Based upon that examination, we
further find that petitioners have failed to carry their burden
of establishing that Delaware Corporation is entitled for 1994 to
the 1994 Virginia Beach property depreciation deduction and for
1995 to the 1995 Virginia Beach property depreciation deduction.
See sec. 167(a).
Legal Fees With Respect to the Mitchums Creek Property
In support of their position with respect to the legal fees
with respect to the Mitchums Creek property, petitioners argue:
The payment of the legal fee by Delaware did not result
in a constructive dividend to Barber because he had
already contracted with Delaware that it would pay all
expenses in recovering the house as part of the consideration for the purchase. * * *
- 48 *
*
*
*
*
*
*
The legal fee was clearly incurred and paid for by
Delaware, which had purchased the property from Barber.
The suit was filed to protect Delaware’s $50,000 investment in the property.
Respondent counters:
the payment of * * * legal fees associated with Barber’s suit against his ex-wife involving their marital
residence constitute[s] constructive dividends to
Barber and petitioners have not argued that the payments constituted compensation to him, deductible by
Delaware Corporation on that basis. * * *
*
*
*
*
*
*
*
* * * In this case, petitioner Barber brought suit
against his ex-wife because she defrauded him out of
their marital residence and he sought rent from his exwife as part of the equitable distribution of marital
property. * * * But for the divorce, Barber would not
have had to bring suit against his ex-wife. Moreover,
Barber brought suit against his ex-wife in his own name
and he, not Delaware Corporation was awarded the property at the conclusion of the litigation. * * * Whatever business justifications petitioners put forward
are simply not sufficient substance to alter the conclusion that the payment was primarily for Barber’s
benefit and a constructive dividend [is] warranted.
On the record before us, we reject petitioners’ argument
that during 1994 Delaware Corporation’s payments of the legal
fees with respect to the Mitchums Creek property do not constitute constructive dividends to Mr. Barber for that year and that
Delaware Corporation is entitled to deduct such legal fees for
that year.
On that record, we agree with respondent that during
1994 such payments constitute constructive dividends to Mr.
- 49 Barber for that year that Delaware Corporation is not entitled to
deduct.
Ms. Barber recorded the Mitchums Creek deed and Mr. Barber
commenced litigation against her in the Middlesex Circuit Court
before he entered into the 1993 global agreement and the Mitchums
Creek contract with Delaware Corporation.
Mr. Barber commenced
that litigation against Ms. Barber in order to assert his interest in the Mitchums Creek property, and not to protect any
interest Delaware Corporation might have had in that property.
Moreover, the Middlesex Circuit Court did not award any interest
in the Mitchums Creek property to Delaware Corporation.
Instead,
that court ordered a rescission of the deed conveying Mr. Barber’s interest in that property to Ms. Barber and a so-called
equitable distribution of the Mitchums Creek property to both Mr.
Barber and Ms. Barber.
On the record before us, we find that petitioners have
failed to carry their burden of establishing that the legal fees
that Mr. Barber incurred in connection with the litigation with
respect to the Mitchums Creek property did not become his obligation to pay as the relevant legal services were rendered.
On
that record, we further find that petitioners have failed to
carry their burden of establishing that during 1994 Mr. Barber
intended to reimburse Delaware Corporation for its payments of
the legal fees with respect to the Mitchums Creek property.
On
- 50 the record before us, we find that petitioners have failed to
carry their burden of establishing that during 1994 Delaware
Corporation’s payments of those legal fees did not confer an
economic benefit on Mr. Barber.
Based upon our examination of the entire record before us,
we find that petitioners have failed to carry their burden of
establishing (1) that Delaware Corporation’s payments during 1994
of the legal fees with respect to the Mitchums Creek property do
not constitute constructive dividends to Mr. Barber for that year
and (2) that Delaware Corporation is entitled to deduct such
legal fees for that year.20
1994 Child Care Expenses and 1995 Child Care Expenses
In support of their position with respect to the disputed
child care expenses, petitioners argue:
Payment of childcare expenses for employees is a deductible expense.
*
*
*
*
*
*
*
* * * Barber received neither benefit nor income
20
Although not altogether clear, petitioners may also be
arguing that Delaware Corporation’s payments of the legal fees
with respect to the Mitchums Creek property do not constitute
constructive dividends to Mr. Barber because such payments were
part of the “consideration for the purchase” of the Mitchums
Creek property. Any such argument not only ignores that a
corporation’s conferring an economic benefit on a stockholder is
a constructive dividend to that stockholder, see, e.g., Magnon v.
Commissioner, 73 T.C. 980, 993-994 (1980), it also is inconsistent with petitioners’ position that Delaware Corporation is
entitled to deduct its payments of the legal fees with respect to
the Mitchums Creek property.
- 51 from DC’s payment of childcare for its employees in
1994 and 1995. Just because the employee [sic] happened to be Barber’s daughters, doesn’t impute receipt
of income to Barber. If there is any imputed income,
it is to the employee [sic], the daughters, not to
Barber.
Respondent counters:
the payment of child care expenses for Barber’s grandchildren * * * constitute constructive dividends to
Barber and petitioners have not argued that the payments constituted compensation to him, deductible by
Delaware Corporation on that basis. * * * The payment
of Barber’s grandchildren’s child care expenses was
inherently personal and primarily benefited petitioner
Barber and not Delaware Corporation. * * *
On the record before us, we reject petitioners’ argument
that Delaware Corporation’s payments during 1994 and 1995,
respectively, of the disputed child care expenses do not constitute constructive dividends to Mr. Barber for those years and
that Delaware Corporation is entitled to deduct such expenses for
those years.
On that record, we agree with respondent that
Delaware Corporation’s payments during 1994 and 1995, respectively, of the disputed child care expenses constitute constructive dividends to Mr. Barber for those years that Delaware
Corporation is not entitled to deduct.
Payments by a corporation for the benefit of relatives of a
stockholder may constitute constructive dividends to such stockholder when made at the direction of, or to satisfy the personal
- 52 wishes of, such stockholder.21
On the record before us, we find
that petitioners have failed to carry their burden of establishing that Delaware Corporation’s payments during 1994 and 1995,
respectively, of the disputed child care expenses were not made
at the direction of, or to satisfy the personal wishes of, Mr.
Barber.
On that record, we further find that petitioners have
failed to carry their burden of establishing that during 1994 and
1995, respectively, Mr. Barber intended to reimburse Delaware
Corporation for its payments of the disputed child care expenses.
On the record before us, we find that petitioners have failed to
carry their burden of establishing that Delaware Corporation’s
payments during 1994 and 1995, respectively, of the disputed
child care expenses did not confer an economic benefit on Mr.
Barber for those years.
Based upon our examination of the entire record before us,
we find that petitioners have failed to carry their burden of
establishing (1) that Delaware Corporation’s payments during 1994
and 1995, respectively, of the disputed child care expenses do
not constitute constructive dividends to Mr. Barber for those
years and (2) that Delaware Corporation is entitled to deduct
such expenses for those years.
21
See, e.g., Hufnagle v. Commissioner, T.C. Memo. 1986-119;
Bongiovanni v. Commissioner, T.C. Memo. 1976-131.
- 53 Accuracy-Related Penalties
Respondent determined that Delaware Corporation is liable
for each of the years 1994 and 1997, that Ms. Havens is liable
for each of the years 1994 and 1995, and that Mr. Barber is
liable for each of the years 1994 and 1995 for the accuracyrelated penalty under section 6662(a) because of:
(1) Negligence
under section 6662(b)(1) or (2) a substantial understatement of
income tax under section 6662(b)(2).
Section 6662(a) imposes an accuracy-related penalty equal to
20 percent of the underpayment of tax resulting from, inter alia,
negligence or disregard of rules or regulations, sec. 6662(b)(1),
or a substantial understatement of income tax, sec. 6662(b)(2).
For purposes of section 6662(a), the term “negligence” includes
any failure to make a reasonable attempt to comply with the Code,
and the term “disregard” includes any careless, reckless, or
intentional disregard.
Sec. 6662(c).
Negligence has also been
defined as a lack of care or failure to do what a reasonable
person would do under the circumstances.
Leuhsler v. Commis-
sioner, 963 F.2d 907, 910 (6th Cir. 1992), affg. T.C. Memo.
1991-179; Antonides v. Commissioner, 91 T.C. 686, 699 (1988),
affd. 893 F.2d 656 (4th Cir. 1990).
An understatement is equal
to the excess of the amount of tax required to be shown in the
tax return over the amount of tax shown in the tax return, sec.
6662(d)(2)(A), and is substantial (1) in the case of an individ-
- 54 ual if it exceeds the greater of 10 percent of the tax required
to be shown or $5,000, sec. 6662(d)(1)(A), and (2) in the case of
a corporation if it exceeds the greater of 10 percent of the tax
required to be shown or $10,000, sec. 6662(d)(1)(B).
The accuracy-related penalty under section 6662(a) does not
apply to any portion of an underpayment if it is shown that there
was reasonable cause for, and that the taxpayer acted in good
faith with respect to, such portion.
Sec. 6664(c)(1).
The
determination of whether the taxpayer acted with reasonable cause
and in good faith depends on the pertinent facts and circumstances, including the taxpayer’s efforts to assess his or her
proper tax liability, the knowledge and experience of the taxpayer, and the reliance on the advice of a professional, such as
an accountant.
Sec. 1.6664-4(b)(1), Income Tax Regs.
Reliance
on the advice of a professional, such as an accountant, does not
necessarily demonstrate reasonable cause and good faith, unless,
under all the circumstances, such reliance was reasonable and the
taxpayer acted in good faith.
Id.
In the case of claimed
reliance on the accountant who prepared the taxpayer’s tax
return, the taxpayer must establish that correct information was
provided to the accountant and that the item incorrectly omitted,
claimed, or reported in the return was the result of the accountant’s error.
Westbrook v. Commissioner, 68 F.3d 868, 881 (5th
Cir. 1995), affg. T.C. Memo. 1993-634; Weis v. Commissioner, 94
- 55 T.C. 473, 487 (1990); Ma-Tran Corp. v. Commissioner, 70 T.C. 158,
173 (1978).
Although not entirely clear, it appears that petitioners are
arguing that they are not liable for the accuracy-related penalties at issue because they sought and received tax advice from
professionals and relied upon such advice in ascertaining the tax
treatment of the disputed property expenses, the Virginia Beach
property depreciation deductions, the legal fees with respect to
the Mitchums Creek property, and the disputed child care expenses
that was reflected in their respective tax returns.
The record establishes that a preparer prepared each of the
following tax returns:
Delaware Corporation’s 1994 return,
Delaware Corporation’s 1997 return, Ms. Havens’s 1994 return, Ms.
Havens’s 1995 return, Mr. Barber’s 1994 return, and Mr. Barber’s
1995 return (collectively, returns in question).
The only
professional on whom petitioners claim to have relied and who
testified at the trial in these cases was Mr. Braun.
No other
professional, including the preparers of the respective returns
in question, testified at trial.
The following colloquy took place on direct examination of
Mr. Braun:
Q
What about the tax aspects of the deductions
that the Delaware Corporation could take or would take
as a result of acquiring these properties where they
assumed debt [i.e., the Caroline County farm and the
Virginia Beach property]?
- 56 A
These properties were basically rental properties. As long as the rent was paid, I felt that they
were valid rental properties.
Q
Could the corporation therefore deduct operating expenses?
A
That’s correct.
Q
Of the rental properties?
A
Yes, sir.
Mr. Braun’s characterization in his testimony of the Caroline County farm and the Virginia Beach property as “basically
rental properties” must have been based on information provided
to him.
We presume that petitioners provided such information to
Mr. Braun.
We have found that petitioners have failed to carry
their burden of establishing that during the years in question
the Caroline County farm and the Virginia Beach property were
rental properties that Delaware Corporation owned.
note 19.
See supra
On the record before us, we find that petitioners have
failed to carry their burden of establishing that they were
correct in informing Mr. Braun that during the years at issue the
Caroline County farm and the Virginia Beach property were rental
properties that Delaware Corporation owned.
On the record before us, we find that petitioners have
failed to carry their burden of establishing that they supplied
correct information to Mr. Braun and to the respective preparers
of the returns in question and that the errors in each of those
returns were the results of errors on the part of Mr. Braun and
- 57 any of such preparers.
Westbrook v. Commissioner, supra; Weis v.
Commissioner, supra; Ma-Tran Corp. v. Commissioner, supra.
On
that record, we further find that petitioners have failed to
carry their burden of establishing that they had reasonable cause
for, and that they acted in good faith with respect to, relying
on any advice of Mr. Braun, or any other professional, regarding
the disputed property expenses, the Virginia Beach property
depreciation deductions, the legal fees with respect to the
Mitchums Creek property, and the disputed child care expenses.
See sec. 6664(c)(1).
Based upon our examination of the entire record before us,
we find that each petitioner has failed to show that such petitioner was not negligent and did not disregard rules or regulations within the meaning of section 6662(b)(1), or otherwise did
what a reasonable person would do, with respect to any portion of
the underpayment for any of the years at issue.
Based on that
examination, we further find that each petitioner has failed to
show that such petitioner acted with reasonable cause and in good
faith with respect to any portion of the underpayment for any of
the years at issue.
See sec. 6664(c).
Based upon our examina-
tion of the entire record before us, we find that each petitioner
has failed to establish that such petitioner is not liable for
the years at issue for the accuracy-related penalties under
- 58 section 6662(a).22
We have considered all of the contentions and arguments of
the parties that are not discussed herein, and we find them to be
without merit, irrelevant, and/or moot.
To reflect the foregoing and the concessions of Delaware
Corporation,
Decisions will be entered
for respondent.
22
We have found that petitioners are liable for the years at
issue for the accuracy-related penalties at issue because of
negligence or disregard of rules or regulations under sec.
6662(b)(1). In light of that finding, we shall not address
respondent’s alternative argument that petitioners are liable for
the years at issue for those accuracy-related penalties because
of substantial understatements of income tax under sec.
6662(b)(2).
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